· · 17 · Sec. 121--Other Exempt Organizations Unrelated Business Income Section 512(b)(3) of the Code currently excludes from the definition of unrelated business income rent from real estate and from personal property leased with such real property. The exception was intended to exclude "passive" investment income from the tax, but as interpreted broadly by the courts, all rents from personal property are excluded if the personalty has any connection with the lease of real estate. This has led to a situation in which an exempt organization may own substantial business assets, which together may constitute an operating business and which are leased to an independent management company. Most of the profits from the business can then be received by the exempt organization in the form of rent, affording a competitive advantage to the exempt organization contrary to the purpose of the unrelated business income provisions. Two amendments to the bill are recommended to insure that income attributable to the active conduct of an unrelated business pays its fair share of tax. First, in order to make clear that only "passive" rental income is excluded from the unrelated business income, section 512(b)(3) should specify that rent from personal property is excluded only when the lease of personal property is incidental to the lease of the realty. The bill should also incorporate the test for "passive" rentals utilized in section 856(d)(1) (dealing with real estate investment trusts). Application of this rule would serve to tax real property rentals in any case where they are measured by reference to the net income from the property, but would exclude rentals based upon a percentage of gross receipts or sales. Income Received by Exempt Organizations from Controlled The House bill includes in the definition of unrelated business income all interest, annuities, rents and royalties received by exempt organizations from controlled corporations. As drafted, the bill would also tax receipts from controlled exempt corporations. Treasury recommends that this provision Investment Income--Fraternal Societies, Employee Associations The House bill treats the investment income of fraternal beneficiary societies or voluntary employees' beneficiary associations as unrelated business income unless it is set aside for a charitable purpose or for the provision of life, sick, accident or other benefits. Treasury recommends that it be made clear that income is set aside for providing these benefits to the extent it is used for the reasonable cost of administration of the benefit program as well as the payment of the benefits themselves. In addition, the income so taxed should be defined to exclude gain on the sale of assets used directly by the organizations in the performance of their exempt functions to the extent the proceeds of sale are reinvested in assets used for such purposes within a period of three years. Thus, gain realized by a fraternal benefit society on sale of its clubhouse facilities and reinvested in replacement facilities within the specified period should not be treated as unrelated business income. 1. Contributions of Appreciated Property Under present law, the deduction of charitable contributions by individual taxpayers is subject to two separate limitations. A general limitation of 20 percent of adjusted gross income applies to all contributions. In addition, gifts to certain publicly supported organizations are permitted up to 30 percent of adjusted gross income. The bill increases the 30 percent limitation to 50 percent of a new contribution base (adjusted gross income plus allowable tax preferences). The bill introduces new rules with respect to gifts of appreciated property. Gifts of appreciated property to certain organizations would either be limited to the taxpayer's basis in the property or would result in a tax on the unrealized appreciation if the taxpayer elected to claim the charitable deduction based on the fair market value of the property. This treatment would apply to gifts of appreciated property to private foundations, other than private operating foundations. Gifts to a private foundation would be excepted from the new rules where the foundation, within one year after its taxable - 21 year in which the contribution is received, applies such contributions to a charitable purpose in a prescribed manner. The bill then provides for a separate 30 percent limitation on gifts of appreciated property which are not subject to the new appreciated property rules (such as a gift to a publicly supported charity of a present interest in appreciated securities constituting a capital asset in the hands of the donor-taxpayer). Thus, some gifts of appreciated property to a private foundation would be subject to this new appreciated property rule and some would not. Furthermore, since the class of organizations subject to the new rule for appreciated property is narrower than those excluded from the old 30 percent (and proposed 50 percent) limit, gifts of appreciated property under the bill are subject to three percentage rules: the 20 percent limit, the new 50 percent limit, and a new 30 percent limit. The bill applies the new appreciated property rule, limiting the deduction to basis or requiring the appreciation to be included in income, to gifts of three classes |